Heterogeneity in price sensitivity

Table10presents OLS estimates for the interaction terms in Equation4. Our results show that there is a certain degree of heterogeneity in price elasticity. Older individu-als are less price sensitive, whereas respondents from British Columbia are relatively more price sensitive than those from other provinces. Insurers may already be aware of the fact that price sensitivity decreases with age since we observe that the money’s worth of annuities decreases in the age of the respondent (as seen in table4). Although there is no segmentation in pricing by province, the heterogeneity in the responses we have suggests that insurers could benefit from a greater use of price discrimination.

Price sensitivity is decreasing in income and increasing in home value, although the second effect is relatively small.

From a public policy’s point of view, as well as from the point of view of marketing annuities in general, the most facinating result that can be observed in the paper’s last table is related to the heterogeneity of the price elasticity of deferred versus immediate lifetime annuity. Being presented a deferred annuity (which we denotedPV(A,M) earlier in the paper) results in lower price sensitivity. This result is particularly inter-esting as it suggests insurers could use product characteristics to price discriminate and charge higher premiums for deferred annuities since they are valued more and

customers are less price sensitive to them. Currently, the most common annuity prod-uct in Canada remains the immediate annuity (which we denotedPV(A, 0)). By hav-ing access to a deferred annuity, asymmetric information cost betweed the annuity provider and consumer would be reduced, and individuals would, perhaps, be able to protect better those years when they no longer have the ability to supplement their retirement income with part-time work.

7 Conclusion

Using a stated-preference experiment, this paper examines the demand for individual annuities in Canada. Our results can be summarized along three main themes: 1-Product mispricing, 2- Small but non-zero price-elasticity of demand, and 3- Little potential growth in absolute terms, but large in relative terms.

With respect to product mispricing, we calculated the money’s worth of different individual annuity products and examined the demand for them. The money’s worth of an annuity is calculated as the present value of the stream of benefits it will pay divided by the current price of such a contract. The money’s worth thus depends on the discount rate, which is independent of each individual’s personal characteristics, and the purchasing individual’s survival probability, which is not. We find that, in Canada, individual annuities are very expensive when analyzed through the scope of an individual’s objective survival probability. In fact, we find that individual annu-ities are objectively over-priced between 11% and 19%, which represent respectively a present value of benefits of $90 and $84 for an initial price of $100. With respect to subjective survival probabilities, however, individual annuities are fairly priced in Canada with a money’s worth of 1.

The difference between the objective and the subjective money’s worth explain our second important result, which is that demand for annuities is price responsive but not very elastic. Unsurprisingly given the result from the money’s worth exper-iment, we find a price elasticity of the demand that is much lower using subjective

mortality risk (an elasticity of -0.33) than using personalized objective risk measures of longevity risk (an elasticity of -0.86).

Despite individual annuities being objectively unfairly priced in Canada, increas-ing competition in the market place, which would surely reduce the price of such a longevity hedging instrument, could lead to an increase in the number of house-holds and/or individuals purchasing annuities. Our estimate is that the increase in the take-up rate would approximately be around 2 percentage points. Given the cur-rent take up rate of 10.65%, a 2 percentage point increase, although small in abso-lute terms, would represent almost 20% increase in the number of annuity contracts sold. In contrast, increasing the consumers’ knowledge of annuities would increase demand by 1.3 percentage points. Consequently, the potential increase in the number of households that would hedge their longevity risk with annuity products is, in the best possible market conditions, 31%, although the absolute increase would only be 3.3 percentage points (from a take-up rate of 10.65% to 13.95%).

The 1.3 percentage point increase in the take-up rate associated with larger aware-ness of Canadians has to be weighted against the decrease in the take-up rate associ-ated with telling Canadians that they over-estimate their survival probability. In trast to increasing competition in the market place which cannot result in fewer con-sumers acquiring an annuity contract, education is a double-edge sword that could lead current purchasers of annuities to realize that they are paying too high a price compared to the objective expected present value of the stream of cash flows they are being promised. Moreover, the price-elasticity of individuals would be likely to increase if they were better educated about their survival probability, thus further reducing their willingness to acquire an annuity if these are not fairly priced.

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Figure 1: Distribution of Money’s Worth of Annuities listed on CANNEX: Life-table,

mi-crosimulation and subjective expectations (Survey)

No Annuity Annuity

Fraction (%) 77.98 Fraction (%) 10.65

Knowledge of annuities (%) Knowledge of annuities(%)

A lot 12.36 A lot 27.67

A little 62.93 A little 65.76

None at all 24.71 None at all 6.57

Why don’t you have an annuity? (%) How did you come to purchase annuity? (%)

Never offered or thought about 19.71 Offered 67.39

Not yet made decision 9.43 Searched myself 21.24

Don’t have sufficient savings 17.36 Other 11.37

Bad value for money 9.19

Doesn’t cover my needs 8.6

No need 21.28

Don’t know what it is 9.01

Other 5.42